8006 Exam Dumps | A futures contract is quoted at 105. Which is the cheapest-to-deliver bond for this contract if there

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Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition
PRMIA.8006.v2021-04-25.q101
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Question 76/101

A futures contract is quoted at 105. Which is the cheapest-to-deliver bond for this contract if there are three available bonds, quoted at 97, 101 and 106 with conversion factors respectively of 0.9, 1 and 1.1 respectively?

A. All the bonds are equally cheap to deliver

B. The bond quoted at 106

C. The bond quoted at 97

D. The bond quoted at 101

Correct Answer: B

Explanation
Treasury bond futures do not specify which bond can be used to effect delivery, but allow the seller to pick from a number of available bonds. As a result, one of these eligible bonds emerges as being the 'cheapest' to deliver, and this CTD bond is determined by the basis between the cash price of the bond and the futures spot price as adjusted by the conversion factor for this specific bond. (ie, basis = Cash Price of the Bond - (Futures Price x Conversion Factor).) The bond with the lowest basis is generally the CTD. In the given question, the three basis calculations are:
1) 97 - (0.9 x 105) = 2.5
2) 101 - (1 x 105) = -4
3) 106 - (1.1 x 105) = -9.5
Since the third bond with a quote of 106 has the lowest basis, Choice 'b' is the correct answer.

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